Risk of 1937 relapse as Fed gives up fight against deflation

Wednesday, June 26, 2013
By Paul Martin

The US Federal Reserve has jumped the gun. It has mishandled its exit strategy from quantitative easing, triggering a global bond rout that it did not anticipate, and is struggling to control.

By Ambrose Evans-Pritchard
TelegraphUK
26 Jun 2013

It has set off an emerging market shock and risks “blowback” from a fresh spasm of the eurozone debt crisis, and it is letting all this happen at the same time, before the US economy is safely out of the woods.

It has violated its own counter-deflation strategy, tightening monetary policy even though core PCE inflation has fallen to the lowest levels in living memory and below levels deemed dangerous enough in the past to warrant a blast of emergency stimulus. It is doing so even though the revival of bank lending has faded.

The entire pivot by the Federal Open Market Committee is mystifying, almost amateurish, and risks repeating the errors made by the Bank of Japan a decade ago, and perhaps repeating a mini-1937 when the Fed lost its nerve and tipped the US economy into a second leg of the Great Depression. “It’s all about tighter policy,” was the lonely lament by St Louis Fed chief James Bullard.

The Fed seems to be acting in the belief that the US economy will shake off this year’s fiscal tightening – 2pc to 3pc of GDP – and that a housing recovery is now entrenched. The sharp fall of Wall Street’s homebuilders index would suggest caution. Unlike the surging Case-Shiller index of house prices, it looks forward, not three months backwards.

The Fed could have kept policy steady, welcoming the shake-out in frothy markets over the past month as a useful “fire-drill” for future QE exit, without pushing its point too far. It chose to escalate.

The Rest…HERE

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